Director’s Duties When Facing Insolvency – What You Should and Shouldn’t Do
When a business begins to struggle, directors often find themselves under intense pressure. Cashflow tightens, creditor contact increases and difficult decisions mount. It is during this period that directors’ legal duties change and the consequences of getting things wrong become very real.
Understanding what is required and what steps to avoid can make the difference between a controlled restructuring and significant personal risk. This article explains the essentials that you need to know.
When Does a Company Become Insolvent?
A company is considered insolvent if either:
- It cannot pay its bills as they fall due (cashflow insolvency), or
- Its liabilities exceed the value of its assets (balance sheet insolvency)
Directors do not need a formal insolvency process to trigger their duties. The moment you know, or should know, that the business is in financial difficulty, you must act.
At this point, your responsibilities shift. Instead of prioritising shareholders, it’s important that you focus on protecting the interests of creditors as a whole.
Your Core Duties When Insolvency Looms
- Put Creditors First
All decisions must be made with creditor outcomes in mind. That may include pausing non-essential spending, reviewing contracts or exploring restructuring options. A key question for every decision is whether it reduces potential losses to creditors.
- Assess the Company’s Position Frequently
Directors must stay informed. That means reviewing up-to-date financial information, forecasting cashflow and holding regular board discussions. If you are a sole director, you should still document your assessments and the reasoning behind any decisions.
- Protect and Preserve Company Assets
Company property must be safeguarded. You should ensure assets are insured, accounted for, and not transferred out of the business without proper justification. Attempts to sell assets cheaply or dispose of them informally can later be challenged.
- Keep Accurate and Comprehensive Records
Good record-keeping becomes critical. Directors may be asked to justify their decisions months or even years later, and clear records of meetings, advice received, and financial data provide essential evidence of responsible conduct.
- Seek Professional Advice Early
Independent advice from insolvency specialists demonstrates that you have taken reasonable steps to understand your obligations and evaluate your options. Early advice often prevents situations from escalating unnecessarily.
- Act Transparently
Whether dealing with lenders, suppliers or employees, honesty matters. Providing misleading information or making unrealistic assurances can lead to allegations of misconduct.
Actions to Avoid – Common Pitfalls for Directors
When facing financial distress, directors must be especially cautious. The following actions can expose you to criticism, personal claims or even criminal penalties.
- Do Not Continue Trading Without a Clear Plan
If the business cannot meet its obligations and there is no realistic path to recovery, continuing to trade may amount to wrongful trading. This can result in personal liability for losses caused by delaying the inevitable.
- Do Not Favour Certain Creditors
Paying off one creditor while ignoring others (particularly if the payment benefits you personally or a connected party) can be classed as a “preference” and may be reversed by a liquidator.
- Do Not Dispose of Assets at Undervalue
Selling assets for less than their true value or transferring them to friends, relatives or associated businesses is a red flag. These transactions can be overturned and may lead to further claims against you.
- Do Not Use Company Funds for Personal Purposes
Directors must not extract money, repay personal loans or take drawings in a way that worsens the position for creditors. Doing so risks misfeasance claims or repayment orders.
- Do Not Declare Dividends to shareholders
Dividends declared at a time of insolvency are illegal and can be reclaimed by any subsequently appointed liquidator or administrator. Similarly, with any overdrawn directors’ loan accounts, these will need to be repaid. PAYE is the safest form of remuneration at this time.
- Do Not Ignore Warning Signs
Late payments, creditor threats, HMRC arrears and declining cash reserves must not be overlooked. Courts expect directors to take swift and documented action in response.
- Do Not Assume Resigning Removes Liability
Walking away from the board does not eliminate responsibility for actions taken while you were in office. Resignation can also be viewed negatively if problems are left to others to resolve.
- Do Not Dismiss Professional Advice
If experts warn you that certain conduct may lead to liability, you must take their recommendations seriously. Failing to follow advice can be used as evidence of misconduct.
What Happens If You Fail to Comply With Your Duties?
Consequences vary depending on the seriousness of the breach, but may include:
- Director disqualification (up to 15 years)
- Personal liability for company debts
- Court orders requiring repayment or compensation
- Criminal investigation in cases involving dishonesty or fraud
Directors are not automatically responsible for company debts, but misconduct can quickly change that position.
Practical Steps to Take Now
If you suspect your company is approaching insolvency, you should:
- Obtain up-to-date financial information
- Document all decisions and the reasoning behind them
- Hold regular board meetings and keep detailed minutes
- Contact an insolvency practitioner for early guidance
- Avoid committing to new liabilities unless you are confident they can be repaid
Taking proactive steps can protect both your creditors and your own position.
We Can Help
Acting early is often the most effective way to minimise risk and preserve value. At Bretts Business Recovery, we work with directors every day to help them understand their responsibilities, stabilise their position and explore the best path forward.
If you are concerned about your company’s financial position or unsure how to fulfil your duties, our team is here to support you.